This CEO Says Crypto Traders May Be 'Shocked' by Their 2021 Tax Bills

The IRS is becoming increasingly strict about making sure anyone who deals in cryptocurrency reports their gains and losses.

Think taxes were confusing before? If you were one of the millions who invested in speculative assets like Bitcoin or nonfungible tokens (NTFs) in 2021, Intuit Inc. Chief Executive Officer Sasan Goodarzi warns you may be "dumbfounded" by your tax bill this year.

According to Goodarzi, "We're gonna see a lot of that throughout tax season, where folks just didn't understand what they did. And there's a lot of millennials that really did a lot of trading without knowing what the implications are."

What are the implications?

Part of cryptocurrency's appeal is that it is decentralized, meaning there are no banks or other central authorities involved. Still, the IRS wants to know about your gains and losses from crypto trades.

Failure to report the sale of cryptocurrency is like failing to report the sale of an office building or plot of land. The IRS expects to be paid its fair share of taxes on any profits.

What you can expect

In the eyes of the IRS, cryptocurrency is not an actual currency. According to IRS Notice 2014-21, cryptocurrency is considered property. All earnings are considered capital gains, just as if you sold a property. Capital gains and losses are reported on Schedule D and Form 8949.

Because the IRS considers cryptocurrency property, we can look at how gains and losses on other property types are treated to better understand what you can expect. Like other property types, how long you hold the cryptocurrency before selling or exchanging it determines whether your gains are considered short-term or long-term. Here's how it breaks down:

• Let's say you owned cryptocurrency for a year or less. You either spent it or sold it before hitting the one-year mark. Any profit is considered short-term capital gains and taxed at your ordinary income tax rate.
• If you held the cryptocurrency for more than a year before spending it or selling it, any profits are taxed as long-term capital gains and subject to the lower tax rate associated with long-term capital gains.

How you received the cryptocurrency matters

How you're required to report your cryptocurrency depends, in part, on how you got it.

Mined cryptocurrency

If you earned cryptocurrency by mining it, you'll report it on Form 1099-NEC at the fair market value on the day you received it. If you don't receive a 1099 form, report it anyway.

Received as payment

Let's say you own a small business and receive cryptocurrency as payment for goods or services. Just as if the customer paid you cash, cryptocurrency counts as taxable income. The dollar value is equal to the fair market value of the cryptocurrency on the day you were paid.

Exchanged

If you trade or exchange one type of cryptocurrency for another, the IRS wants to know. For example, let's say you have $1,000 worth of Bitcoin and exchange it for $1,000 worth of Ethereum. If you originally paid $600 for the Bitcoin, you must report $400 in capital gains. After all, you ended up making $400 on the exchange.

Where things get tricky

The IRS becomes interested when you eventually sell or spend the cryptocurrency. Remember, it's not considered a currency but is considered property.

Let's say you own a lawn business and receive $500 worth of cryptocurrency for your services in July. By December, the cryptocurrency you received had increased in value and is now worth $750. You use the cryptocurrency to purchase $750 worth of plane tickets for a family vacation. At tax time, you'll need to report the $500 you were paid for your services as ordinary income and a short-term capital gain of $250 (the amount by which the value of the cryptocurrency increased).

Fortunately, you can usually download a full transaction report from a cryptocurrency exchange platform. This report includes all the buys, sells, and exchanges on your account. If you work with several exchanges, remember to download a report from each.

Tempted to cheat?

If the idea of omitting cryptocurrency transactions from your tax returns ever occurs to you, banish the thought. According to the IRS, only a fraction of people currently involved with buying, selling, or trading cryptocurrencies properly report their transactions at tax time.

2020 tax returns were the first returns to include the question, "At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?" Hiding the truth may be difficult to explain if you're ever audited.

However, the IRS is not alone in tax enforcement efforts. Congress recently passed into law the Infrastructure Act (not to be confused with Build Back Better). This act includes several cryptocurrency-related amendments to make it easier for the IRS to identify cryptocurrency transactions and tie those transactions to the parties involved.

These amendments will make identifying which taxpayers sell or exchange cryptocurrency easier. Although new reporting requirements are not effective until after December 31, 2023, it's a safe bet the IRS is already taking a closer look at cryptocurrency-related transactions.